Bank of Canada hiked interest rates to ‘forcefully’ tame inflation. Will it work?

The Bank of Canada took a big step in raising interest rates on Wednesday, but how long will it take before rampant inflation starts to cool off?

Experts say the Bank of Canada’s efforts to tackle inflation with oversized interest rate hikes will take time to bring price growth back to normal levels as the central bank races to catch up with an economy that’s bouncing back stronger than first anticipated.

The Bank of Canada raised the target for its overnight rate to one per cent on Wednesday, delivering a rare 50-basis-point hike to the benchmark interest rate.

Governor Tiff Macklem told reporters Wednesday morning that the oversized step was necessary to rein in inflation and economic growth that had surpassed the central bank’s original forecasts.

“With inflation well above target, with the economy moving in excess demand, there is a need to normalize monetary policy relatively quickly,” he said.

While the Bank of Canada’s outlook in January pegged the annual rate of inflation at an average of five per cent through the first half of the year, it now expects inflation levels of six per cent across the first six months of 2022.

The key thing the bank didn’t anticipate when it held its rate at historic lows of 0.25 per cent in January was the war in Ukraine, which has pushed inflation higher through elevated prices on commodities such as gasoline and food.

But it also didn’t expect the economy to bounce back quite as quickly as it has. A robust jobs market — unemployment is now below pre-pandemic levels — is driving demand and consumer spending at a feverish pace, Macklem said.

The larger step marks a departure from the bank’s usual approach to rate hikes, which aim to take the steam out of the economy by raising the cost of borrowing for Canadians. The last time it raised rates by half a percentage point was May 2000.